California public agencies that impose transient occupancy (hotel) taxes may be limited in the tax they can collect from online transactions. The California Supreme Court on Monday ruled that TOT are limited to the “wholesale” price online travel companies pay to a hotel to obtain a room, not the marked-up “retail” price the OTCs actually charge hotel customers. Public agencies that impose TOT should review their ordinances to determine whether an update is necessary. Any such update, however, will require voter approval.
In In re Transient Occupancy Tax Cases, the City of San Diego, along with a class of similarly situated California resort cities (e.g., Los Angeles, Anaheim, etc.) sought to require OTCs to remit TOT to the City based upon the full retail amount they charge their customers online.
Under a “merchant model” transaction, OTCs charge a customer a total rate, which represents the amount it costs the OTC to “buy” the room from the hotel (the wholesale rate) plus any retail mark-up for the OTC’s profit (often identified as “service” or “convenience” fees). However, OTCs only collect TOT from customers based upon the wholesale rate and forward this amount along to the hotel, which then remits it to the city in which the hotel is located. The end result is that a city doesn’t receive TOT on the full retail rate the customer actually paid for the room. For example, an OTC charges its customers a retail rate of $150 per night, and pays a wholesale rate of $100 to “buy” the hotel room. A city imposes a 10 percent TOT. As such, the OTC only collects $10 ($100 x 10 percent) from the customer, although 10 percent of the customer’s actual retail charge would be $15 ($150 x 10 percent).
The court looked specifically to the City’s ordinance, which imposes a TOT “in the amount of 6 percent of the rent charged by the operator.” However, the ordinance defines “operator” to mean “the person who is the proprietor of the hotel… whether in the capacity of owner, lessee, sublessee, mortgagee in possession, licensee, or any other capacity,” including managing agents. After reviewing this definition, the court concluded that hotels, but not OTCs, are “operators” under the ordinance. Therefore, the retail markup that OTCs set is not subject to the TOT because this markup is not “rent charged by an operator.” The TOT may only be imposed on the wholesale rate the actual hotel charges for a room. Under the City of San Diego’s TOT ordinance, in merchant model transactions, the City asserted that the additional $5 in TOT should have been collected by the OTCs and remitted to the City. The Supreme Court disagreed, finding that the TOT is payable only on the wholesale rate (i.e. the $100).
Because this case turns entirely upon the interpretation of the City’s ordinance, public agencies with similarly worded ordinances can address this problem by updating their local municipal code. However, because this update would change the methodology for imposing the tax by expanding the taxing base, voter approval under Proposition 218 will be required.
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